Market Structures Economics Mr. Bordelon

Market Structure Market structure. The organization of a market based on the degree of competition among producers. Perfect competition Monopoly Oligopoly Monopolistic competition

Characteristics of Market Structures Number of Producers Similarity of Products Ease of Entry into Market Control over Prices

Perfect Competition In a perfectly competitive market, a large number of firms produce essentially the same product. All goods are sold at their equilibrium price. This is the most efficient market structure. Rare. Mostly agricultural. Examples. Wheat, corn, tomatoes, milk, commercial fishing, paper industry.

Characteristics of Perfect Competition Monopoly Oligopoly Monopolistic Competition Perfect competition Many producers and consumers Identical products Easy entry into the market No control over prices. Most Competitive Least Competitive

Characteristics of Perfect Competition Many producers and consumers. Large number of participants promotes competition. Identical products. Buyers don’t really see a difference: milk is milk. Commodity. A product that is exactly the same no matter who produces it. Grains, cotton, sugar, oil.

Characteristics of Perfect Competition Easy Entry into Market. Few restrictions. Existing producers will face competition from new firms, and no single firm will dominate the market. No Control over Prices. Producers can not influence prices because there are too many other producers offering the same product. Market forces of supply and demand determine price of goods (Invisible Hand!).

Barriers to Entry Barrier to Entry. Obstacle that can restrict access to a market and limit competition. Start-up costs. Initial expense of starting a business. Financial capital. Control of resources. Both physical and human capital. Technology.

If this is rare, why is perfect competition important? Perfect competition is the standard by which we measure all the other markets. One structure to rule them all, one structure to find them...one structure to measure them all and in the darkness box them squarely on the ears.

Questions 1. Which of the following is NOT a condition for perfect competition? (a) many buyers and sellers participate (b) identical products are offered (c) market barriers are in place (d) buyers and sellers are well-informed about goods and services 2. How does a perfect market influence output? (a) Each firm adjusts its output so that it just covers all of its costs. (b) Each firm makes its output as large as possible even though some goods are not sold. (c) Different firms make different amounts of goods, but some make a profit and others do not. (d) Different firms each strive to make more goods to capture more of the market.

Questions 1. Which of the following is NOT a condition for perfect competition? (a) many buyers and sellers participate (b) identical products are offered (c) market barriers are in place (d) buyers and sellers are well-informed about goods and services 2. How does a perfect market influence output? (a) Each firm adjusts its output so that it just covers all of its costs. (b) Each firm makes its output as large as possible even though some goods are not sold. (c) Different firms make different amounts of goods, but some make a profit and others do not. (d) Different firms each strive to make more goods to capture more of the market.

Monopoly Monopoly. Market or industry consisting of a single producer of a product that has no close substitutes. Monopolies are generally illegal. Government uses antitrust laws to limit the formation of monopolies. One key thing to remember throughout monopoly: control of price and output!

Characteristics of Monopoly One producer Unique product High barrier to entry High control over price Monopoly Oligopoly Monopolistic Competition Perfect competition Most Competitive Least Competitive

Characteristics of Monopoly One producer. No competition. The monopoly is the market. Unique product. Monopolies are the only supplier of the product. No good substitutes, no similar goods or services. What kind of product did we call this? The one where no matter how high the price went, consumers would still keep buying it?

Characteristics of Monopoly High Barriers to Entry. Since the monopoly controls everything, it’s difficult if not impossible to get into the market at all. High Control over Prices. Monopolists control price and output. They can set price without fear of being undercut by competitors. They can limit supply and create a shortage to raise the price even further.

Legal Monopolies Natural Monopoly Government Monopoly Patent Copyright Public Franchise License

Natural Monopoly Natural monopoly. When a single firm can supply a good or service more efficiently and at a lower cost than two or three competing firms can. Examples. Utilities, airports. Because natural monopolies are efficient, governments view them as beneficial.

Natural Monopoly Economies of scale. Greater efficiency and cost savings that result from increased production. Businesses that acheive economies of scale lower its average cost per unit of production by increasing its output and spreading fixed costs over a larger quantity of goods. Huh?

Natural Monopoly Economies of Scale cont’d Bob the Builder has been asked to supply water to a new subdivision of 50 houses. To do this, it will cost his company $100,000 to put the pipes in. It costs an addition $1,000 to put in a meter. Total cost for supply water to the first home: $101,000

Natural Monopoly Economies of Scale cont’d But what about the second home?

Natural Monopoly Economies of Scale cont’d But what about the second home? Total cost for two homes: $102,000 OR per home: $51,000

Natural Monopoly Economies of Scale cont’d And the third?

Natural Monopoly Economies of Scale cont’d And the third? Total cost for three homes: $103,000 OR per home: $34,333

Natural Monopoly Economies of Scale cont’d By the time you get to the 50th house, the total cost to Bob the Builder is $150,000--$100,000 for the pipes and $50,000 for 50 meters. Cost per home: $3,000

Natural Monopoly Economies of Scale cont’d Businesses that acheive economies of scale lower its average cost per unit of production by increasing its output and spreading fixed costs over a larger quantity of goods. In other words, it costs me less to build per unit because I can spread out the cost of the whole project to each product I build. Bob the Builder’s average total cost will decrease as he increases his production!

Natural Monopolies Economies of Scale cont’d So...wait, if it works for Bob the Builder, why can’t it also work for Bobbette the Builder?

Government Monopolies Patents and Copyrights Patents give inventors or creators the right to control production, sale and distribution of their technical work. Copyrights grant artists, writers and composers the right to control a creative work. We want to encourage investment in research and development, and creativity.

Government Monopolies Public Franchise. Contract issued by government entity that gives a firm the sole right to provide a good or service in a certain area. Usually for a reduced cost of product. Examples. National parks, schools, vending machines. Licenses. Legal permit to operate a business or enter a market. Examples. Road paving company, parking lot company.

Questions 1. A monopoly is (a) a market dominated by a single seller. (b) a license that gives the inventor of a new product the exclusive right to sell it for a certain amount of time. (c) an industry that runs best when one firm produces all the output. (d) an industry where the government provides all the output. 2. Price discrimination is (a) a factor that causes a producer’s average cost per unit to fall as output rises. (b) the right to sell a good or service within an exclusive market. (c) division of customers into groups based on how much they will pay for a good. (d) the ability of a company to change prices and output like a monopolist.

Questions 1. A monopoly is (a) a market dominated by a single seller. (b) a license that gives the inventor of a new product the exclusive right to sell it for a certain amount of time. (c) an industry that runs best when one firm produces all the output. (d) an industry where the government provides all the output. 2. Price discrimination is (a) a factor that causes a producer’s average cost per unit to fall as output rises. (b) the right to sell a good or service within an exclusive market. (c) division of customers into groups based on how much they will pay for a good. (d) the ability of a company to change prices and output like a monopolist.

Oligopoly Oligopoly. Market or industry dominated by just a few firms that produce similar or identical products. Arise because of economies of scale, which give bigger producers an advantage over smaller ones. Some competition. Firms in an oligopoly do not have to be as large.

Characteristics of Oligopoly Monopoly Oligopoly Few producers Similar products High barriers to entry Some control over price Monopolistic Competition Perfect competition Most Competitive Least Competitive

Characteristics of Oligopoly Few Producers. Small number of firms control the market. If top four producers supply more than 60% of the market, then this is an oligopoly. Similar Products. Same product, minor variations.

Characteristics of Oligopoly High Barriers to Entry. High start-up costs, existing firms may have made large investments and enjoy economies of scale, customers reluctant to give up loyal to old brands. Some control over price. Some competition. Firms influenced by price decisions of other firms in market— interdependence.

When Oligopolies Behave Badly Oligopolies are not in and of themselves illegal. However, they can act illegally. Or sometimes just misbehave.

When Oligopolies Behave Badly Price Leadership. In an oligopoly dominated by a single firm, the dominant firm sets a price and other smaller firms may follow. However, dominant firm may cut prices in order to take business away from competitors or force them out of business—anti-competitive! Bad! If others lower their prices, market could enter a price war, benefiting consumers, but bad for sellers.

When Oligopolies Behave Badly Collusion. When producers get together and make agreements on production levels and pricing. Illegal. Unfairly limits competition.

When Oligopolies Behave Badly Cartel. Organization of producers established to set production and price levels for a product. Illegal in the United States. Not on global market. OPEC. Organization of the Petroleum Exporting Companies often set price and output (hey, that sounds familiar!) artificially. Works primarily with commodities: oil, sugar, coffee, etc.

When Oligopolies Behave Badly Key point! When firms in an oligopoly work together to control the market, they act like a monopoly. As such they can use market power to limit competition and raise prices.

Monopolistic Competition Monopolistic Competition. Large number of producers provide goods that are similar but varied. Oftentimes this means creating a brand, which consumers will show brand loyalty to.

Characteristics of Monopolistic Competition Monopoly Oligopoly Monopolistic Competition Many producers Differentiated products Few barriers to entry Some control over prices Perfect competition Most Competitive Least Competitive

Characteristics of Monopolistic Competition Many Producers. Many competitors means more competition. Differentiated products. Similar product, with significant variations. Product differentiation. Distinguish g/s from other firms, even when those products are close substitutes for each other. Examples. Shoes—Nike, Reebok. Computers—HP, Apple.

Characteristics of Monopolistic Competition Few Barriers to Entry. Start-up costs are relatively low. Many firms can enter and earn a profit. Some Control over Prices. Because producers control their brands, they have some control over price. BUT because products are close substitutes, market power is limited. If prices raise too much, customers will substitute. Too many producers for price leadership or collusion to be possible.

Questions 1. The differences between perfect competition and monopolistic competition arise because (a) in perfect competition the prices are set by the government. (b) in perfect competition the buyer is free to buy from any seller he or she chooses. (c) in monopolistic competition there are fewer sellers and more buyers. (d) in monopolistic competition competitive firms sell goods that are similar enough to be substituted for one another. 2. An oligopoly is (a) an agreement among firms to charge one price for the same good. (b) a formal organization of producers that agree to coordinate price and output. (c) a way to attract customers without lowering price. (d) a market structure in which a few large firms dominate a market.

Questions 1. The differences between perfect competition and monopolistic competition arise because (a) in perfect competition the prices are set by the government. (b) in perfect competition the buyer is free to buy from any seller he or she chooses. (c) in monopolistic competition there are fewer sellers and more buyers. (d) in monopolistic competition competitive firms sell goods that are similar enough to be substituted for one another. 2. An oligopoly is (a) an agreement among firms to charge one price for the same good. (b) a formal organization of producers that agree to coordinate price and output. (c) a way to attract customers without lowering price. (d) a market structure in which a few large firms dominate a market.

Price Discrimination Price Discrimination. Division of customers into groups based on how much they will pay for a good. Market Power. Ability of a company to change prices and output. Targeted Discounts. Discounts aimed at characteristics of a particular consumer—elderly, students, military, etc.

Price Discrimination Some market power. MUST have some control over prices. Distinct consumer groups. Divides customers into distinct groups based on sensitivity to price. Difficult resale. If one group of customers could buy the product, then resell it to someone else for a profit, then the firm can not enforce price discrimination.

Non-Price Discrimination Non-price competition. Competition through ways other than lower prices. Differentiation. Making a product different from other similar products.

Non-Price Discrimination Physical characteristics. Location Service Level Advertising, Image, Status